The U.S. Treasury Department is due to report to Congress by April 15th on whether or not it considers China to be a “currency manipulator.” (See the above-linked Reuters article.) Such a determination could be tantamount to an economic declaration of war. Under World Trade Organization rules, a nation who determines that another is manipulating the exchange rate is then free to impose tariffs to rectify the situation. Such a move by the U.S. to restore a balance of trade would threaten China with economic collapse.
Nevertheless, the time has come. With its policy of pegging the yuan to the dollar instead of allowing market forces to determine the exchange rate, China clearly is a currency manipulator. Of course, so too is virtually every other nation, including Japan and the Euro zone. The only difference is that they’re much more subtle about it, leaving their exchange rate to the whims of market forces, but then manipulating those market forces. It’s not as effective as China’s policy, but they’re able to compensate for any erosion in exchange rate by using other tactics to maintain their trade surpluses with the U.S. So the end result is the same with one exception. It strips the U.S. of the ability to label them as currency manipulators.
Will the Obama administration make such a move? I doubt it. They’ve yet to show any real backbone in international trade, failing to respond to huge, new Mexican tariffs on American exports or to blatant dumping by Japanese auto manufacturers. However, as the economic stimulus plan winds down and as the Federal Reserve ends its programs to pump trillions of dollars into the economy, Obama faces the reality that it simply hasn’t worked. Though they’ve been trumpeting the growth in GDP, they know very well that the effect is temporary and that the economy is likely to sink back into recession as the stimulus spending is exhausted. And there’s no appetite for more deficit spending. With credit dried up and without phony economic bubbles (the housing bubble being the most recent example) to create the illusion of prosperity, Obama knows that real improvement in the economy depends on a rebound in the manufacturing sector, which has had the life sucked out of it by the trade deficit.
The jobs temporarily salvaged by the stimulus plan have only carried him so far, and its effects are waning. So with a 2nd term now hinging on a restoration of private sector manufacturing jobs, we may yet see the administration grow a spine in international trade. Why not label China a currency manipulator? There’s really nothing to fear. Will China dump its U.S. treasury holdings, which some fear may drive interest rates sky-high in the U.S.? Perhaps, but the threat of higher interest rates is way over-blown.
First of all, the rest of the world will see any move by the U.S. to restore a balance of trade as a huge boost to the U.S. economy, driving strong demand by other countries for U.S. treasuries. Those sold by the Chinese will be quickly snapped up. If anything, interest rates may even fall. Secondly, in the past year, the Federal Reserve has purchased more U.S. treasuries than the total of Chinese holdings. Whatever slack there might be in demand for the U.S. treasuries sold off by China can easily be made up by the Federal Reserve. And finally, since China will still be dependent on exports to the U.S. to prop up their economy, they will still be left with a lot of dollars looking for a home. What else can they do except use them to purchase treasuries? I suppose they could also use them to buy oil, but then the oil exporters will have to purchase treasuries. In the final analysis, the demand for U.S. treasuries will remain strong regardless of what China does.
There is the possibility of an unintended consequence. A move by the U.S. to restore a balance of trade with China may be perceived as such a positive for the U.S. economy and such a negative for China’s that, once unpegged from the dollar, the yuan may actually rise very little or could even fall against the dollar. Imagine the laughter and gloating that would be coming from China then!
I do find it a little awkward supporting the branding of China as a currency manipulator because exchange rates really aren’t the problem. Currency exchange rates tend to stabilize not at a level that restores a balance of trade but at a level where unemployment equalizes, leaving a permanent trade imbalance between nations grossly disparate in population density. When has a change in exchange rate ever reversed a trade imbalance? Never. Since the 1970s, the dollar has fallen by over 300% vs. the Japanese yen. Yet, during that time, our trade deficit with Japan has actually exploded. More recently, when the yuan was allowed by the Chinese to rise by 20% a couple of years ago, our trade deficit with China only grew worse. And, as the dollar has fallen in the past year vs. the yen and euro, the prices for imports from those regions at the retail level have actually declined. Japanese automakers have aggressively cut prices in spite of the falling dollar.
The problem is that badly overpopuated nations will never let something so trivial as currency exchange rates erode their share of the U.S. market. They know very well that their economies are utterly dependent on manufacturing for export and that subsidizing their manufacturers in order to maintain U.S. market share is a very, very small price to pay.
So, while there’s no hope that an end to the blatant currency manipulation by China can reverse our trade deficit, labeling China as a currency manipulator will place into our hands the one weapon that can – tariffs. And, once successfully employed against China, resulting in an economic renaissance in the U.S., the advocates of unfettered free trade and protectionism bashers will be exposed as liars and fools. And it will beg the question: if it’s successful with China, why not Japan and Germany and Mexico and others? How much sense would it make to remain a member of the World Trade Organization at all?
So, in the end, we may owe a big thanks to China for their clumsiness with the currency issue if it turns out to be the first crack in America’s golden idol of free trade. Perhaps this will be the first nudge in a turn away from the far left end and back toward a more centrist trade policy that makes sensible use of both free trade and protectionism as necessary to maintain a balance of trade. I’m skeptical, but we’ll soon see.